Resource Commodities

Fund manager Adrian Day takes a look at the gold market and recent results from two of the royalty companies in his portfolio, and gives some suggestions of companies that he sees as good buys.

Gold has had a difficult few months. After a modestly upward trend until mid-April, gold then started its downward trajectory, falling from $1,350 to well under the psychologically important $1,200 mark in a (final?) collapse the last week. The U.S. economy, stock market, and particularly the dollar have all been broadly positive for most of the year, making it a difficult environment for gold, with demand for the metal sliding; U.S. coin sales hit 10-year lows, reflective of this lack of demand.

Turkey responsible?

But indifference has now turned to hostility, as, in the last couple of weeks, amid its currency crisis, Turkey is thought to have been a heavy seller of physical gold. It makes sense; after China and India, Turkey and Russia have been the largest buyers of physical gold since 2008, with a pick-up over the last three years. In a crisis, one sells liquid assets, all the more if the price has gone up in local currency terms (viz. Venezuela).

If this is the main cause of gold's sharp decline in the last week or so, then it is of necessity a temporary phenomenon. The U.S. economy, stocks and the dollar may stay reasonably strong—for now at any rate—so gold won't suddenly explode upwards, but we could reasonably expect a near-term return above $1,200 towards the mid-$1,200s. (On Friday, gold bounced $11 from its low of $1,174.)

Vanguard out of gold business

Amid this gold decline and a collapse in sentiment, Vanguard decided to get out of the gold market. The largest precious metals fund by far—virtually twice the size of the next largest—is to change its name and mandate from the Precious Metals Fund to the Global Capital Cycles Fund; it has already replaced its London-based gold manager to a U.S. firm not known for any gold expertise or interest.

We suspect that the heavy volumes on many gold stocks reflect the new manager cleaning house, a typical phenomenon when a new manager takes over a fund. This has been going on since the new manager took over at the end of July, with the XAU index down from over 77 to under 66 this month. But in the last week, amid the drop in gold, this decline changed to a cascade, with some big-cap miners seeing one-day declines of 5%–9% on heavy volume.

Vanguard shunning gold at this point may prove to be a contrary indicator of historical proportions. Again, if this is the explanation for much of the gold selling, then it too is a temporary phenomenon, and we can equally expect a bounce in the gold stocks once the selling precious is off. (The XAU moved from 64.29 to 65.92 on Friday.)

Capitulation in gold

Amid all this, sentiment has turned extremely negative, as evidenced by the latest CFTC data, showing speculators went net short for the first time since the end of 2001. At that time, gold was $275 an ounce and within a year was at $348, within six years at $900.

Peter Boockvar of Bleakley Advisory Group, to whom acknowledgements for pointing out the data, comments "it's tough to find a more contrarian indicator."

This, plus the largest gold fund changing its mandate, is as close to capitulation as one can get. The short-term recovery could be as sharp as the decline, once the selling pressure is gone. This gives us the opportunity to buy great companies on sale, as well as to make some short-term trades is grossly oversold stocks.